Sydney bias? Better reserve that judgement

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The Reserve Bank board is routinely criticised for being too
Sydney-centric, but if that were really the case it wouldn't be
considering a rate rise tomorrow.

Allegations of big-city bias have become habitual for some
National Party MPs who seem to believe every rate increase proves
the board ignores the needs of the bush.

When the Reserve raised rates twice in late 2003 there were
howls of complaint that it was only interested in cooling the
Sydney property market. At that time, National Party Senator Julian
McGauran distinguished himself by accusing the Reserve of being
"very urban-centric" and demanding the board be changed.

But the bank's decision to lift rates last month, and the strong
possibility it will lift rates again this week, shows what nonsense
the Sydney bias claims are.

The debate around the board table tomorrow morning would be
quite different if the Reserve was setting interest rates just with
Sydney in mind.

After more than a decade of economic dazzle, the city is
vulnerable.

That's not a word often associated with Sydney, which has
benefited hugely from the two drivers of Australia's strong
economic performance - the housing boom and the super-strong
consumer spending it helped fuel.

But these are giving way to new growth drivers focused elsewhere
- the resources boom and related business investment.

There is a growing band of economists who believe Sydney may go
through the wringer as the economy rebalances.

In December, Ross Garnaut, professor of economics at Australian
National University, sounded an early warning when he predicted
Sydney would suffer "exceptional economic stress" as resources
flowed away from the big cities to the north and west. This will be
a "big part of the Australian story" in the next few years, he
says.

Now Access Economics has added its voice. "The aftermath of the
housing price boom is proving problematic for Sydney," it says in
its quarterly Business Outlook report published today.

There are at least four reasons for Sydney's economic weakness,
three of which are linked to the house price boom.

First, high property prices are driving people away. Despite the
popular myth that Sydney is bursting at the seams, the city's
population growth lags even Hobart. Despite accounting for a third
of Australia's population, NSW has had just a 20 per cent share of
national population growth in the past two years - a proportion
that has only twice been lower in the history of federation. The
relative weakness in population growth is sapping economic output
from Sydney and NSW.

Second, Sydney's debt-laden households have become far more
cautious as the house price boom turns sour. The last round of rate
increases in November and December 2003 had a considerable impact
on Sydney. Families have become more focused on saving rather than
spending and this has taken an inevitable toll on economic
activity. Last month's rate increase, and the possibility of
renewed house price weakness, will make families in Sydney even
more careful. Retail trade in NSW has been much weaker than the
rest of Australia and there is anecdotal evidence that some Sydney
retailers are starting to feeling the pinch.

Third, the combination of weak population growth and the cooling
property market has hurt the housing construction industry, an
important driver of employment in NSW since before the 2000 Olympic
Games. Other sectors important to the city's economy but dependent
on the housing boom, such as property and business services, are
also likely to come under increased pressure.

Fourth, the strength of the resources boom, fuelled by Chinese
demand, has negatives for NSW. While the benefits for NSW from this
boom are limited compared to other some states, it has helped buoy
the Australian dollar which is, in turn, hurting Sydney's
manufacturing and services exporters.

Also, the strength of mining is drawing business investment away
from NSW to the north and west. "NSW's business investment to
output ratio has lagged the national equivalent for some years,
briefly gaining traction with pre-Olympic construction works, yet
lagging even further behind now as investment heads for the
resource hotspots," Access Economics says.

Not surprisingly, the resource-rich states of Western Australia
and Queensland are performing far better than NSW.

Conversely, the NSW economy, which has been lagging other states
for some time, flatlined in the second half of last year, according
to the Bureau of Statistics.

Access Economics has forecast economic growth in NSW will be 0.9
per cent this financial year, way behind Queensland (3.4 per cent)
and Western Australia (3.9 per cent).

The relatively poor performance of NSW is reflected in its jobs
growth, which has been a third of the rate of the rest of Australia
over the past three years.

The unemployment rate in NSW - among the lowest of the states
for many years - is now above the national average (5.2 per cent
versus 5.1) and considerably higher than Queensland (4.5 per cent),
Western Australia (4.6 per cent) and ACT (3.5 per cent in original
terms). The unemployment rate in NSW is now on par with South
Australia's.

NSW's mediocre jobs performance pre-dates last month's increase
in interest rates, which will have a disproportionate effect on
Sydney because of high debt levels.

The most damaging consequence of the state's slowdown is the
prospect of rising unemployment over the next 18 months.

Access Economics has forecast the jobless rate in NSW to rise to
5.8 per cent in 2006-07, swelling the ranks of the unemployed in
the state by about 26,000.

National Australia Bank is tipping the national unemployment
rate to rise to about 5.75 per cent in the second half of this year
and drift towards 6 per cent in 2006.

It is possible the strong global economy will come to the rescue
and boost the services sector, invigorating the Sydney's crucial
white-collar jobs market and limiting any upswing in
unemployment.

But families in Sydney - who have led Australia's recent debt
binge - are so heavily leveraged even a small rise in the jobless
rate will cause a lot of jitters.

The Reserve might have shown it is not Sydney-centric but it
will still be watching the city's reaction to higher interest rates
very closely.